Could quake jolt Japan from its slumber?

Commentary: Government needs to goose the economy

By

JonMarkman

SEATTLE (MarketWatch) — Ever since the stunning end of a massive credit binge in the 1980s, Japan has been a punching bag for the global economy, demographics and nature. Its companies and households have been shrinking and deleveraging for two decades, its government finances have teetered on the brink of ruin and its cultural and political influence have ebbed into a sad and shadowy irrelevance.

The last thing that Japan needed now was an earthquake, tsunami or nuclear energy catastrophe, but with any luck it can turn Friday’s terrible turn of events to its favor. Its fate could hardly get worse.

Let me give you background and perspective, and then some thoughts on what might happen next.

Like the United States and Europe in the past two years, Japan tried to solve the bursting of its incredible credit bubble in 1990 by putting private borrowing on the public books. The country now has a gross debt to gross domestic product ratio of 220%, which is a number so large that it boggles the conscience.

It’s a little hard to believe, but Japan — once so thrifty and elegantly rich — has reached twice the level of indebtedness of Greece.

Despite this high debt level, the government will now have to dig deep and spend whatever it takes to rebuild its northeastern coastline, for the impacted area provides 16.5% of all GDP and 19.5% of all employment income in Japan.

Float more debt, keep yen from rising

To pay for reconstruction, Japan will need to float a lot more debt, and must keep the yen from rising to keep new borrowing costs manageable. It will also buy a lot less U.S. debt, which means the Federal Reserve will almost certainly have to launch QE3 when the lifespan of QE2 is up in June to prevent bond prices from crashing and rates from rising.

The reason the yen is so strong is that the country has a huge current account surplus and thus massive piles of foreign assets in addition to its own debts. Basically, it buys very little from other countries except bonds.

It’s amazing that the household savings rate is actually higher now in the United States than in Japan — something that was almost unthinkable five years ago.

This is not how most Americans think of the two countries, but that is the reality today. We were so afraid of Japan Inc. in the late 1980s, and now they are a sliver of a shell of a husk of their former selves.

So this is the broad demographic backdrop for the disaster. All sophisticated investors know this already, and many have lost fortunes trying to take advantage of the country’s plight over the years by shorting Japanese government bonds, called JGBs for short, or the yen.

Now the paradox is that Japan is also the world’s largest foreign creditor. Through the end of 2009, its net foreign assets were around $3 trillion, according to Goldman data, which dwarfs even the total in China.

Many economists now recommend that Japan become an aggressive seller of yen. This would boost the competitiveness of the country’s exporters like Toyota
TM, +0.90%
Honda
HMC, +7.30%
Kubota
KUB, +0.00%
and Sony
SNE, -2.64%
It would help to jump start GDP growth and jack up Japanese stocks. The Japanese central bank can also directly buy Japanese equities, and without doubt will do so.

American business people would normally squawk at this blatant manipulation, but this time they will likely stand aside.

Ruined plants as a metaphor

Japan has clearly written off these damaged, 40-year-old nuclear plants, flooding them with caustic seawater, in an effort to avoid a more tragic outcome. Perhaps that’s a metaphor for the markets overall. Japan’s creaky old economy may have to be gutted before it can grow again.

It may take a while for stocks cool and stabilize — figure as much as three to six months — as current quarter earnings are slashed due to a halt in production. But if the BOJ does begin a meaningful campaign to push down the yen and goose the economy, Japan’s long path to deflation could finally end. A revival in Tokyo would help emerging markets as they would need to buy raw materials and possibly even bring in workers. There could be a silver lining on this dark cloud.

Whatever happens next, do not draw a straight line between the condition of Japanese stocks and U.S. stocks. The two went in opposite directions in 1995 after the Kobe earthquake, in which 6,500 people lost their lives and a major industrial port was knocked out.

I covered the massive Kobe earthquake in 1995 as a reporter for the Los Angeles Times, and understand first-hand the horrors of the aftermath of this sort of destructive force. I spent many days reporting from the cold, smoky, disease-infested school buildings that were used as refugee housing, where families that were living middle-class lives a few days before were suddenly reduced to a couple of blankets’ worth of space in an unheated building.

And they were the lucky ones, because tens of thousands of people opted to camp outside in flimsy plastic-tarp tents despite the icy temperatures as they were afraid of dying in a building during the many aftershocks. The cold made everything worse. When you hear that the Japanese government is shutting down power as much as three hours a day in coming weeks, keep in mind that it is winter, and temperatures are below freezing at night.

Japanese leaders made big mistakes during the Kobe disaster that they seem to have made strides toward fixing this time. You have probably heard that they refused outside aid in 1995, but it was actually worse than that. The local government in Kobe did not even want help from other parts of the country, as medical teams from Hiroshima were turned away.

The culture of self-reliance is very strong in Japan, and deeply embedded in the memories both of those who lived through the depravations of the 1940s war and their children and grandchildren. Before that, Japan was a profoundly agrarian, largely feudal country lacking in the north-to-south cohesiveness. Each section of the country has acted in many ways autonomously, so it has been refreshing so far to see what appears to be a broad, joint effort launched quickly this time.

It would be awesome if Japan could honor its dead by allowing the tsunami to help wash away two decades of economic disaster. This is a perfect time for a change of policy in favor of a weaker yen and stronger growth.

Jon Markman is a MarketWatch columnist. He runs a money-management and investment-advisory firm in Seattle. For more ideas like these, try a two-week trial to Markman’s daily investment newsletter, Strategic Advantage, published in partnership with MarketWatch, or his daily trading newsletter, Trader’s Advantage. Follow Markman on Twitter @jdmarkman.

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